Summary
- An employee works within your business and is part of your organisation, while a contractor runs their own business and provides services to you.
- The classification depends on the real working relationship, including control, independence, payment structure and who bears risk.
- You cannot label someone a contractor to avoid obligations, as regulators may reclassify them as an employee.
- This guide explains the difference between employees and contractors for Australian business owners and how to assess the relationship in practice.
- It is prepared by LegalVision’s business lawyers, a commercial law firm that specialises in advising clients on employment classification matters.
Tips for Businesses
Assess the working relationship, not just the contract. Consider control, independence and payment structure before deciding. Ensure agreements reflect reality and meet tax and superannuation obligations. Review arrangements regularly to avoid misclassification risks and potential penalties.
On this page
- How Can I Minimise Risk?
- What is the Australian Tax Office Test for Determining This?
- Should I Keep Records?
- What are the Main Points of Difference Between an Employee and a Contractor?
- What is the Difference Between an Employment Contract and a Contractor’s Contract?
- What are Different Tax Requirements?
- Key Takeaways
- Frequently Asked Questions
An employee works within and as part of your business, while a contractor runs their own independent business and provides services under a contract. Getting this distinction right is critical, as it determines your legal obligations around pay, tax, superannuation, and entitlements, and misclassification can expose your business to penalties and back payments. This article explains the key differences between employees and contractors and why it matters for your business.
How Can I Minimise Risk?
Businesses that fail to acknowledge this very real distinction are at risk of being penalised. These penalties include:
- a monetary penalty for failing to meet Pay As You Go (“PAYG”) withholding requirements;
- a super guarantee charge for failing to make the correct superannuation contributions, which consists of:
- the shortfall (up-to-date payments);
- the interest on the shortfall; and
- an administrative fee.
What is the Australian Tax Office Test for Determining This?
When taking a new employee, you need to confirm whether he or she is an employee or contractor before entering into the agreement. An employee typically works as part of a larger organisation. A contractor is running their own business under their own Australian Business Number. To determine whether your worker is an employee or contractor, use the ATO online tool.
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Should I Keep Records?
You need to keep records to support your decision on whether your worker is an employee or contractor, and the factors you relied on.
What are the Main Points of Difference Between an Employee and a Contractor?
Ability to Sub-Contract or Delegate
Employees cannot sub-contract or delegate their work and cannot pay someone else to do their work for them. Contractors, however, can delegate or sub-contract and pay someone else to do the job.
Basis of Payment
Employees are paid in salaries, hourly rates and on commission-based structures. Contractors are paid on varying bases, including a one-off payment due after the job.
Equipment
In an employer-employee relationship, the employer usually pays for the business equipment. Contractors typically provide and maintain their equipment and tools.
Risk
Employees are generally not at commercial risk while employed, as the employer has legal responsibility for the actions of its employees while at work. Contractors, however, are responsible for their conduct and the commercial risks of the work.
Control Over Work
Employers are expected to give employees direction regarding the type of work required and how the work is performed. Contractors can perform the job as they choose, provided they adhere to the terms and conditions of the agreement.
Independence
An employee and employer are working for the same business and the same goals. Contractors run their businesses independently of the hirer. They can elect whether or not they will do extra work (depending on the terms of the contract) and are allowed to enter agreements with third parties.
What is the Difference Between an Employment Contract and a Contractor’s Contract?
A contractor’s contract is an agreement between a company (known as the “principal”) and a service entity (known as the “contractor”).
An employment contract is an agreement between employer and employee and establishes the terms and conditions of the employment. It can be verbal or written.
The agreements address the different legal requirements of the employee or contractor relationship, including:
- term and payment;
- insurance, taxation, superannuation and reporting; and
- subcontracting, exclusivity and restraint and termination provisions.
What are Different Tax Requirements?
Employers are required by the ATO to make compulsory superannuation guarantee contributions to the superannuation fund chosen by the employee, or, alternatively the employer’s fund. On top of this, employers withhold PAYG tax from any income paid out to employees as required by law.
Contractors have very different taxation requirements. In contrast to employers, they themselves are responsible for meeting their taxation and superannuation obligations. Employers are generally not required to make tax deductions from any amount that the contractors have been paid.
As an employer, understand your essential employment obligations with this free LegalVision factsheet.
Key Takeaways
The ATO test used to determine whether a worker is an employee or a contractor is quite stringent. Even if someone seems like they’re working in a contractor’s capacity, the test may determine otherwise. Instead of guessing, take the test yourself and avoid paying superannuation penalties and fines.
If you need assistance with the ATO test, our experienced tax lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Employees cannot sub-contract work, are paid on salaries or hourly rates, and the employer provides their equipment. Contractors, however, can sub-contract, manage their own business, and provide their own equipment.
Employers withhold PAYG tax and make superannuation contributions for employees, while contractors handle their own tax and superannuation obligations.
An employee works in and as part of your business, while a contractor runs their own business and provides services to you. The distinction depends on the overall working relationship, not just the label in the contract.
The classification affects tax, superannuation, leave entitlements and legal obligations. Employees receive statutory benefits, while contractors generally do not, and getting it wrong can lead to penalties and back payments.
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